Sterling Battered and Bruised By Bank

In this week’s US Dollar update by Moneycorp:
Weak data and high government borrowing work against sterling. Bank hobbles it twice in a week. Dollar held back by investor optimism.

By Tuesday morning sterling had added a cent from Monday’s $1.6550 starting point. A sharp two and a half cent drop was followed by a much slower upwardly-biased consolidation and on Thursday it was back up above $1.6550. From there it was downhill all the way and sterling opened in London this morning at $1.6150.

It was as if sterling could do no right last week. Almost everything that could go wrong did go wrong. Inflation ticked lower with the Consumer Price Index just +1.6% higher on the year. Disappointing employment figures showed unemployment at its highest level in 13 years. Analysts at BNP Paribas published a research paper saying that sterling is heading for parity with the euro. UK retail sales did not increase at all in August. Lloyds Banking Group failed a “stress test” on its toxic assets. Public sector net borrowing in August, £18 billion, was twice as much as the previous month and everyone can see it will head even higher despite the government’s reluctant recognition of the need for spending cuts.

But it was not the economic data that did sterling in. Depressingly, it was the Bank of England again. Governor Mervyn King was talking to parliament’s Treasury Committee on Tuesday when he mentioned one possible way of encouraging banks to behave more liberally with their cash. He said he would consider cutting the Bank of England’s Discount Rate (as opposed to the Bank Rate that drives base rates) to discourage banks from bouncing the quantitative easing money straight back to Threadneedle Street as reserves. Upon hearing the word “cut” investors stampeded for the exit. The pound tanked.

Not content with the damage, the Bank was back again this morning with its Quarterly Bulletin. One of the sections, entitled “Interpreting recent movements in sterling”, offered possible reasons for sterling recently weak showing. The bit that captured the imagination of the media this morning was a phrase in the summary of the 13-page document. It said “sterling’s depreciation may be part of a more prolonged process of rebalancing of the UK economy, generating a fall in the long-run sustainable real exchange rate”. Investors were quick to interpret the comment as an official recognition that sterling is doomed.

The dollar struggled through the week, held back by buoyant equity markets and a generally gung-ho attitude to risk among investors. When they are feeling optimistic investors feel little need for the protection offered by the dollar and the yen. Nor was the dollar helped by the tolerably decent US economic data that kept cropping up. Federal Reserve offices in New York and Philadelphia both published manufacturing indices that were appreciably better than a month earlier. New York’s Empire State index went up by six points to 18.9 and the Philly figure added ten points to come in at 14.1. Retail sales went up by a provisional +2.7% in August. To top it all, Federal Reserve Chairman Ben Bernanke said it was “very likely” that the recession had ended. With reassurance like that to lean on, nobody needs the dollar’s crutch.

Sterling is so horrible that even its own central bankers hate it. At least, that is the impression at the beginning of the week. The only glimmer of hope is that the recent news and performance has been so awful that there is nothing left to hurt it. But it is way too risky to assume that a bounce is inevitable simply because it has come a long way down. Buyers of the dollar should continue to hedge three quarters of their requirement with a forward purchase. If the underlying transaction is in the relatively near future it would not be silly to cover all of it.

For more information and expert guidance on the currency markets, call Moneycorp today on +44 (0)20 7589 3000, do not forget to mention International Horizons to secure the best rates. Alternatively go to the Moneycorp Website where you can open a free, no obligation Trading Facility.

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